The dominant narrative out there holds that a U.S. recovery is in full swing, powered by a rebound in home prices and better auto sales. But at least two bright minds have a different view of what lies ahead for the newly elected president.
Jeremy Piger of the University of Oregon calculates the probability of a recession based on four factors: non-farm payroll employment, industrial production, real personal income, and manufacturing and trade sales. His numbers, published on the Federal Reserve Bank of St. Louis website, say the odds of a recession have risen sharply in recent months.
Granted, his model indicates there is only a 20 per cent chance that a recession is about to begin. But the index has never hit that level since the late 1960s without a recession following closely after.
If nothing else, Prof. Piger's findings will provide some consolation to Lakshman Achuthan of the Economic Cycle Research Institute (ECRI) in New York. Mr. Achuthan was arguably the most followed economic forecaster in the world after successfully predicting both the deep recession of 2008 and the ensuing recovery. But in September of 2011 he declared that the U.S. was on the brink of a new recession and has stuck to that call ever since.
Mr. Achuthan, now the object of derision in financial circles, is coy about his methodology (not that anyone's been asking recently). In the past, however, he has talked about the importance of comparing forward-looking economic indicators with data measuring coincident, or current, levels of activity. When forward-looking data like industrial new orders are rising faster than current economic growth, conditions are likely to improve – or so the theory goes.
The chart at left shows the ratio of ECRI's Leading Economic Index versus Coincident Index (a rising line indicates an improving outlook for economic conditions) and compares that ratio to the S&P 500 index. It offers a graphic rationale for Mr. Achuthan's projections. In May of 2011, the leading indicator/coincident indicator ratio made a sharp move lower just a few months before he made his official recession call. Unfortunately for him, the S&P 500 ignored the trend and moved higher.
The question is whether the close relationship between the leading/coincident indicator and the S&P 500 will reestablish itself. If so, the current flattening of the blue line suggests that despite most economists' outlook, the future economy is unlikely to grow much faster than it is at present. Mr. President, you have been warned.